Yesterday the Supreme Court in David Browne Contractors Ltd v Petterson clarified the meaning of “due debts” in s292 of the Companies Act and, in doing so, upheld the Court of Appeal’s decision setting aside two transactions made by a company to related companies.

Background

Polyethylene Pipe Systems Ltd (in liq) (‘Polyethylene’) was part of a group of companies operated by David Browne. Polyethylene entered into a subcontract with McConnell Dowell to weld pipes that were to be laid on the seabed of Lyttelton Harbour as part of a major sewer outfall project. In late 2007 and early 2008, two of the welds failed and there were further concerns about a third weld. McConnell Dowell gave notice of its intention to seek recovery of its costs because of the failures.

Mr & Mrs Browne, the directors of Polyethylene, put in place a scheme to restructure the company’s affairs and strip Polyethylene of its assets. Polyethylene repaid unsecured advances from three related parties, David Browne Contractors Ltd (‘Contractors’), David Browne Mechanical Ltd (‘Mechanical’), and Mr Browne totalling $1,253,537. Polyethylene then granted a General Security Agreement (‘GSA’) to Mr Browne in return for $450,000 of new funding.

Mr & Mrs Browne signed a solvency certificate stating that the contingent liability to McConnell Dowell was disputed, would be offset by counterclaims for extras and variations, and, in any event, would be covered by McConnell Dowell’s insurers.

In late August 2008, McConnell Dowell wrote to Polyethylene with a detailed breakdown of the losses it claimed, which totalled $2,552,671. Three days later, Mr Browne transferred $700,000 to Polyethylene on the basis that it would be secured by the GSA. On 2 September 2008, Polyethylene paid the debts owed to Mr Browne ($340,600), Contractors ($565,303) and Mechanical ($347,634).

At an adjudication under the Construction Contracts Act 2002, McConnell Dowell’s losses were assessed as $2,965,334. Mr Browne responded to the adjudication by appointing receivers to Polyethylene, which was subsequently put into liquidation. The liquidator, David Petterson, sought to set aside the payments made on 2 September 2008 as insolvent transactions under s292 of the Companies Act 1993 ('Act').

Mr Petterson was unsuccessful in the High Court in seeking an order for repayment of the 2 September payments, and that the GSA be set aside under sections 293 (voidable charges) and 299 (court may set aside certain securities and charges) of the Act. The Court of Appeal overturned that decision. It set aside the GSA, and ordered that Contractors and Mechanical repay the amounts of $565,303 and $347,634 respectively to Polyethylene. Mr Browne was also ordered to repay $201,316 to the company, which he received as a creditor under the GSA.[1]

Supreme Court decision

The Supreme Court unanimously upheld the Court of Appeal’s decision that Contractors and Mechanical return the 2 September payments to Polyethylene.[2] The main issue on appeal was whether payments to Contractors and Mechanical occurred at a time when Polyethylene unable to pay its “due debts”.

Contractors and Mechanical unsuccessfully argued that ‘due debts’ under s292(2)(a) of the Act must be legally due. The Supreme Court disagreed. It said that ‘debt’ can mean both present and contingent debts. It also accepted that contingent debts can be due debts if they are “reasonably temporally proximate”. There was sufficient certainty for the McConnell Dowell contingent claim to be treated as a debt due in a cash flow solvency assessment. The Court said that:[3]

Solvency in a cash flow sense must be assessed objectively, taking a practical business prospective. What is reasonably temporally proximate will, as indicated above, fall to be considered in light of the facts of the particular case. If a reasonable and prudent business person would be satisfied that there is sufficient certainty that a contingent debt will, within that relevant period, become legally due then it must be taken into account.

The Court rejected arguments by Contractors and Mechanical that they had defences available under s296(3) of the Act, as Mr Browne was aware of the risk that Polyethylene was liable to McConnell Dowell, and of the high risk of insolvency. Mr Browne did not act in good faith, which means that Contractors and Mechanical also did not act in good faith when their loans were repaid.[4]

Contractors and Mechanical also argued that s295 of the Act provided the Court with a residual discretion to deny a liquidator recovery if that would cause unfairness to a creditor. It was not necessary for the Court to decide this point, but it doubted whether there remains such a discretion when no defences are available.

Our comments

This is a pragmatic judgment by the Supreme Court that recognises that, in some circumstances, “due debts” will include both present and contingent debts. The case also serves as a warning to directors that they can’t ignore reasonably proximate contingent claims when restructuring a company’s affairs.

The decision illustrates why it is important to have a robust voidable transactions regime to ensure that related party creditors are not preferred over ordinary creditors. The need to protect creditors from related party preferences was highlighted in the Insolvency Working Group’s recent second report, which recommends that the period of vulnerability for related party voidable transactions should be four years prior to the date of liquidation or the date of a liquidation application.[5]

To read a copy of the judgment, please click here. If you would like to know more about the Supreme Court’s decision, please contact us.

Kensington Swan acted for Mr Petterson in the appeal and proceedings. Bret Gustafson, a former partner of the firm, argued the appeal and acted as counsel for Mr Petterson.

[1] During the High Court hearing, the liquidator abandoned a claim against Mr Browne for the payment of $340,600 and that the GSA was a voidable charge.[2] The Supreme Court had refused leave to appeal against the Court of Appeal’s decision setting aside the GSA and order that Mr Browne repay $201,316 to Polyethylene ([2016] NZSC 107).[3] At [91].[4] At [126].[5] The clawback period for both related and non-related creditors is currently two years from the date of liquidation, or the date of a liquidation application.